The Business
Herbalife is a $4.3 billion global nutrition company that helps ordinary people pursue a healthy lifestyle with an emphasis on weight management. Herbalife’s product suite ranges from weight-loss programs to nutritional and personal care goods. It currently operates in 87 countries and employs around 5,000 people.
Herbalife uses a multi-level marketing business model to sell its products worldwide. Multi-level marketing (MLM) is a method of direct selling that compensates its sales force not only for the sales they personally generate, but also for the sales of people they recruit. MLM has a negative perception due to its similarities to illegal pyramid schemes, and its concentration on the recruitment of a personal sales force.
The Problem
Over the past few months, Bill Ackman’s hedge fund, Pershing Square Capital Management, has undertaken a substantial short position (~20 million shares or ~20% of float) against Herbalife. His investment thesis states that Herbalife is a pyramid scheme because more revenue is recognized from the recruitment of Herbalife’s sales force than from the actual sale of their products. Using the media, Ackman has asserted numerous accusations, hoping to enlighten investors and regulators about the fraud. Ackman states that his thesis is only realized when Herbalife share price touches $0. In December 2012 and early January 2013, Ackman saw unrealized gains of 35% as Herbalife tumbled.
Contrary to Pershing Square, two major financial participants have sided with Herbalife. Daniel Loeb of Third Point Capital has undertaken an 8% long position, while Carl Icahn, a billionaire corporate raider, has not disclosed his stake. Both investors state that Ackman’s claims are unfounded and “preposterous”. Recently, Icahn and Ackman discussed Herbalife on CNBC where they eventually resorted to the schoolyard tactic of name-calling. The ongoing battle has inspired confidence in Herbalife as the stock rallied in late January 2013 and erased Ackman’s 35% gains.
What’s Next?
Icahn has threatened to tender an offer for Herbalife, insinuating that Ackman would suffer the “mother of all short squeezes”. The threat is probably more inflammatory than valid, but nonetheless remains a possibility. Secondly, there are several pending lawsuits and investigations that call the validity of Herbalife into question. If any of these investigations conclude with a definitive answer, the stock market will most likely respond accordingly. On January 30th 2013, the FTC shut down Fortune Hi-Tech Marketing for running an illegal pyramid scheme. Herbalife closed down around 4% even though there are no direct implications for the company. Although the outcome is uncertain, markets are inherently zero-sum. The conviction behind both financial mammoths means only one thing: someone is going to lose a lot of money.
